Gold Stable, Strong Risk/Reward Ratio Seen

Gold prices remained in a tight range this morning, mirroring movements in the Euro as has been the case for several weeks now. The metal traded as high as $1660 per ounce this morning before falling back to the $1650 range on a slightly stronger dollar. ETF holding levels have remained very stable, indicating little action on either the buy or sell side of the market. For the moment, gold is awaiting a catalyst to push it out of its current trading range. The questions now are what will break gold free of this range and in which direction will it likely move?

Uncertainty about the resolution of the EU debt crisis has been the main issue paralyzing gold over the last several weeks. While Euro zone politicians and finance officials are desperately seeking a solution to the crisis, the dollar has temporarily reasserted itself as the safe haven play of choice. Made even stronger by the slumping Euro, the high flying dollar has sucked much of the luster out of gold for the time being.

Rumors surfaced yesterday that a new expansion of the EU bailout fund to the tune of over $2 trillion was being considered behind closed doors. Should this rumor prove true, it will no doubt shore up many of the concerns about the EU collapsing which would certainly provide a drastic increase in gold buying. With the additional bailout funds allocated in Europe, global fears would again turn to currency debasement and the dollar would likely fall from these drastically overbought levels. Any further action out of Europe aimed at solving their debt crisis will be bullish for gold prices.

On the other hand, a disorderly collapse of the EU could put short term downward pressure on gold. If the Euro continues to slide and make the dollar stronger by comparison, gold prices could come under some pressure and move lower. That said, there is a crucial piece of the demand picture that will drastically limit gold’s downside. If you recall last month’s correction, physical buying has stepped in to limit price decreases significantly. Several central banks and other institutions accounted for well over 20 tons of physical gold purchases in the last two months, most of which were conducted below the $1650 level. With the Indian gift giving season underway, and the holidays coming in the west, physical demand for gold is underpinning prices in a big way.

The relationship between these two scenarios creates a pretty unique situation from an investment standpoint. It is widely assumed that European leaders will spare no expense in addressing their crisis. If this turns out to be true, gold prices will surely resume their rise. If, on the other hand, EU officials fail to reach an agreement, physical buying will drastically limit downside below $1600. As a result, the downside risk is likely quite minimal at the moment, where the upside potential points to at least $2000 per ounce. Though many new comers to gold are probably sitting on the sidelines waiting for some sort of signal, these current levels may actually present one of the best tactical buying situations we have seen yet this year.